Options strategies in Stock Market
Traders often dive into options trading without fully grasping the breadth of available strategies. However, understanding these strategies can significantly enhance their ability to manage risk and optimize returns. Options offer versatile tools that allow traders to capitalize on various market scenarios, whether bullish, bearish, or neutral. With a strategic approach, traders can harness the power of options to their advantage.
1. Covered Call
A covered call strategy is popular among investors seeking to generate additional income from their stock holdings while potentially selling them at a higher price. This strategy involves owning the underlying stock and simultaneously selling a call option on that same stock. By selling the call option, the investor collects a premium, which provides immediate income. The call option gives the buyer the right to purchase the stock at a specified price (strike price) by a certain date (expiration date). If the stock price remains below the strike price at expiration, the call option expires worthless, and the investor keeps the premium received.
For example, suppose an investor owns 100 shares of XYZ stock trading at ₹4100 per share. They could sell a call option with a strike price of ₹4600 for a premium of ₹166 per share, expiring in one month. If XYZ stock stays below ₹4600 by expiration, the investor keeps the ₹16600 premium. If XYZ rises above ₹4600, the investor may be obligated to sell their shares at ₹4600, missing out on potential gains above that price. Covered calls are effective in neutral to slightly bullish markets where the investor is comfortable potentially selling their shares at the strike price.
2. Married Put
A married put strategy is used primarily for downside protection while allowing participation in potential upside gains. In this strategy, an investor purchases shares of a stock and simultaneously buys a put option on the same stock. The put option gives the investor the right to sell the stock at a specified price (strike price) by a certain date (expiration date). This strategy acts as insurance against a decline in the stock price. If the stock price falls below the strike price of the put option, the investor can exercise the put option, limiting their losses.
 For instance, if an investor buys 100 shares of ABC stock at ₹5020 per share and buys a put option with a strike price of ₹4600 for ₹166 per share, expiring in three months, they are protected against the stock falling below ₹4600. If ABC stock declines to ₹4100, the investor can sell the stock at ₹4600 through the put option, limiting their loss to ₹418 per share (₹5020 purchase price – ₹4600 strike price – ₹166 put premium). The married put strategy is suitable for investors holding stocks with unrealized gains who want to protect against downside risk without selling their shares.
3. Bull Call Spread
A bull call spread strategy is employed when an investor expects moderate upside movement in the price of a stock. This strategy involves buying a call option at a lower strike price and simultaneously selling another call option with a higher strike price, both with the same expiration date. The goal is to profit from a modest increase in the stock price while limiting potential losses.
For example, suppose an investor believes that XYZ stock, currently trading at ₹4100, will rise moderately over the next month. They could buy a call option with a strike price of ₹3760 for ₹250 per share and simultaneously sell a call option with a strike price of ₹4600 for ₹83 per share. The net cost of the spread is ₹166 per share (₹250 cost of buying call – ₹83 premium received from selling call). If XYZ stock rises above ₹4600 at expiration, the investor’s maximum profit is capped at ₹250 per share (difference between strike prices – net cost of spread). Bull call spreads are beneficial in stable to mildly bullish markets where the investor wants to capitalize on potential gains while reducing the upfront cost of purchasing a call option outright.
4. Bear Put Spread
A bear put spread is a strategy used by investors who anticipate a moderate decline in the price of a stock. This strategy involves buying a put option at a higher strike price and simultaneously selling another put option with a lower strike price, both having the same expiration date. The objective is to profit from a decrease in the stock’s price while limiting potential losses.
For instance, if a stock is trading at ₹4183 and an investor expects it to decline moderately, they might buy a put option with a strike price of ₹4600 for ₹250 per share and simultaneously sell a put option with a strike price of ₹3765 for ₹83 per share. The net cost of the spread is ₹166 per share (₹250 cost of buying put – ₹83 premium received from selling put). If the stock falls below ₹3765 at expiration, the maximum profit is ₹250 per share (difference between strike prices – net cost of spread). Bear put spreads are useful in bearish markets or when the investor wants to hedge against potential downside while limiting upfront costs.
5. Protective Collar
A protective collar is a strategy employed by investors holding a long position in a stock who want to protect against downside risk while limiting potential gains. This strategy involves buying an out-of-the-money put option to protect against a decline in the stock’s price and simultaneously selling an out-of-the-money call option to generate income, typically to offset the cost of buying the put.
For example, suppose an investor owns 100 shares of XYZ stock, currently trading at ₹8300 per share. They could buy a put option with a strike price of ₹7950 for ₹166 per share and simultaneously sell a call option with a strike price of ₹8305 for ₹83 per share. The net cost of the collar is ₹83 per share (₹166 cost of buying put – ₹83 premium received from selling call). The protective collar limits potential losses if the stock price drops below ₹7950 (put strike price), but the investor may be obligated to sell the stock at ₹8305 (call strike price) if the stock rises above that level. Protective collars are suitable for investors looking to hedge against downside risk without selling their stock outright.
6. Long Straddle
A long straddle strategy involves purchasing a call option and a put option on the same underlying asset with the same strike price and expiration date. This strategy is used when an investor expects significant volatility in the stock price but is uncertain about the direction of the price movement.
For instance, if a stock is trading at ₹4183 and an investor buys both a call option and a put option with a strike price of ₹4183 for ₹335 each, they will profit if the stock price moves significantly above or below ₹4183 by more than the combined cost of the options (₹670 in this case). The maximum loss for the investor is limited to the total cost of buying both options. Long straddles are beneficial in highly volatile markets or during events such as earnings announcements where significant price movements are anticipated.
7. Long Strangle
A long strangle strategy is similar to a long straddle, but involves buying an out-of-the-money call option and an out-of-the-money put option on the same underlying asset with the same expiration date. This strategy is used when an investor expects a substantial price movement in the underlying asset but is unsure of the direction of the movement.
For example, if a stock is trading at ₹4183, an investor might buy a call option with a strike price of ₹4600 for ₹250 per share and a put option with a strike price of ₹3765 for ₹166 per share. The total cost of the strangle is ₹418 per share (₹250 for call + ₹166 for put). The investor will profit if the stock price moves significantly above ₹4600 or below ₹3765 by more than the total cost of the strangle. Long strangles are useful in volatile markets where the investor expects a sharp move in the stock price but is uncertain about the direction.
8. Long Call Butterfly Spread
A long call butterfly spread combines aspects of both a bull call spread and a bear call spread. This strategy involves buying one call option at a lower strike price, selling two call options at a middle strike price, and buying one call option at a higher strike price, all with the same expiration date.
For instance, if a stock is trading at ₹4183, an investor might buy a call option with a strike price of ₹3765 for ₹166 per share, sell two call options with a strike price of ₹4183 for ₹83 per share each, and buy a call option with a strike price of ₹4600 for ₹42 per share. The net debit for the butterfly spread is ₹42 per share (₹166 cost of lower call – ₹166 received from middle calls + ₹42 cost of higher call). The maximum profit is achieved if the stock price equals the middle strike price (₹4183 in this case) at expiration, resulting in the maximum gain of ₹42 per share. Long call butterfly spreads are used when an investor expects minimal movement in the stock price.
9. Iron Condor
An iron condor strategy involves combining a bull put spread and a bear call spread on the same underlying asset with the same expiration date but different strike prices. This strategy is used when an investor expects the price of the underlying asset to remain within a certain range.
For example, if a stock is trading at ₹4183, an investor might sell a put option with a strike price of ₹3765 for ₹166 per share and buy a put option with a strike price of ₹3350 for ₹83 per share, while simultaneously selling a call option with a strike price of ₹4600 for ₹166 per share and buying a call option with a strike price of ₹5020 for ₹83 per share. The net credit for the iron condor is ₹166 per share (₹166 received from put spread – ₹83 cost of put spread + ₹166 received from call spread – ₹83 cost of call spread). The maximum profit is achieved if the stock price remains between the middle strike prices (₹3765 and ₹4600 in this case) at expiration.
10. Iron Butterfly
An iron butterfly strategy is similar to an iron condor but involves selling an at-the-money put and call option and buying out-of-the-money put and call options on the same underlying asset with the same expiration date. This strategy is used when an investor expects the price of the underlying asset to remain stable at the strike price of the sold options.
For instance, if a stock is trading at ₹4183, an investor might sell a put option and a call option with a strike price of ₹4183 for ₹250 per share each, while simultaneously buying a put option with a strike price of ₹3765 for ₹83 per share and a call option with a strike price of ₹4600 for ₹83 per share. The net credit for the iron butterfly is ₹166 per share (₹250 received from selling options – ₹83 cost of buying options). The maximum profit is achieved if the stock price equals the strike price of the sold options (₹4183 in this case) at expiration.
These strategies provide a range of approaches for investors to manage risk and potentially profit from various market conditions, whether bullish, bearish, or neutral. Each strategy has its own risk-reward profile and is selected based on the investor’s outlook on the underlying asset and market conditions. Understanding these strategies allows investors to effectively use options as part of their overall investment strategy.
